Standard setting organizations (SSOs) and their members often face the “holdup” problem. Holdup refers to the ability of patent owners to extract surplus from downstream licensees after a standard has been adopted and licensees have made sunk investments in the chosen technology. The “Intellectual Property Conference Report” recently released by the FTC and DOJ Antitrust Division (IP Report) has important implications for how SSOs may deal with this problem. While the agencies’ Intellectual Property Guidelines did not consider how SSOs might address holdup, the IP Report encourages innovative SSO rules and practices. In particular, the IP Report clarifies the agencies’ policy towards the most controversial practice SSOs use to deal with the holdup problem, ex ante licensing negotiations. This part of the report expands on previous agency business review letters and speeches. Nonetheless, substantial uncertainty remains concerning when that practice may be used.

The IP report states that multilateral ex ante licensing negotiations will be considered under the rule of reason and will not be considered a per se offense. Such negotiations may lead to the exercise of monopsony power and licensing rates below the competitive level, with potential negative effects on innovation incentives. Nonetheless, the rule of reason is applied because these negotiations may also lead to important offsetting efficiencies by eliminating the possibility of holdup. Unfortunately, the IP Report provides only limited guidance as to when the antitrust authorities are likely to find such multilateral licensing negotiations objectionable under the rule of reason.

In encouraging ex ante negotiations, the IP Report appears to assume an ex ante world where numerous alternative technologies compete for inclusion in the standard based both on technical merit and on licensing terms. If these conditions do not hold, the agencies might find joint negotiations to be anticompetitive. The IP Report says that joint ex ante licensing negotiations may raise competition concerns if (a) the standard incorporates a patented technology that has no viable alternatives; (b) the standard does not enhance the IP holder’s market power; and (c) all potential licensees refuse to license that technology except on agreed-upon licensing terms. In these situations, the IP Report finds that “the ex ante negotiation among potential licensees does not preserve competition among technologies that existed during the development of the standard but may instead simply eliminate competition among potential licensees for the patented technology.”

Setting up such a dividing line basically says that unless efficiencies from ex ante multilateral bargaining can be demonstrated, entering into such negotiations may raise antitrust problems. This position seems to assume an anticompetitive outcome unless potential licensees or the SSO show that technologies currently compete and that ex ante licensing will preserve that competition. Thus, the rule of reason may be cold comfort to those contemplating the possibility of multilateral ex antenegotiations because patent holders and potential licensees will find it difficult to determine whether all the criteria for pro-competitive ex ante negotiations are likely to be met.

The IP Report says that a rule of reason analysis will be applied to ex ante multilateral discussion, but does not say how that analysis will be carried out. The Report does not even delve in any detail into one of the most difficult issues in this connection: under what conditions the SSO could set an artificially low price for IP included in the standard. The IP Report does not describe how any potential for exercise of monopsony power by SSO members might be traded off against likely benefits from reducing the opportunity for holdup. Rather, the IP Report focuses on the risks that the ex ante licensing discussions could be a sham (a) by IP holders to cover up naked agreements on the licensing terms they will offer the SSO or (b) by SSO members to cover up naked agreements to fix the prices of the products they sell.

The main procompetitive reason to have multilateral ex ante licensing negotiations is to mitigate the market power of patent holders that the SSO may create by incorporating a technology in a standard. Therefore, if the negotiations succeed, SSO members who must license the technology will pay less than if there were no negotiations and they were “held up.” How does one distinguish the lowering of licensing rates that comes with lessening the opportunity for holdup from the exercise of “monopsony power” by potential licensees in the SSO? Both the elimination of holdup and the exercise of monopsony power have the same goal-to lower licensing rates. The IP Report sheds little light on this key question.

The IP Report, surprisingly, says little about another much-discussed suggested solution to the holdup problem: the SSO’s requiring patent holders to agree in advance to license at a reasonable and nondiscriminatory (RAND) royalty. There has been a great deal of discussion in the recent literature regarding how such rates might be determined and enforced. To some degree, RAND policies could be substitutes for multilateral ex ante licensing discussions. While the IP Report mentions a number of suggested approaches to defining RAND rates, it does not comment on their relative merits. More generally, it would have been helpful to hear what the agencies think about the relative usefulness of ex ante commitments to RAND rates as opposed to ex ante negotiations.

The IP Report’s rejection of per se treatment of ex ante royalty negotiations in a standard setting context is a substantial move beyond the IP Guidelines. Nonetheless, SSOs and the IP owners who are considering forming SSOs still face significant uncertainty concerning the antitrust treatment of those negotiations.

Robert D. Stoner has worked on a number of matters involving the economics of intellectual property and standard setting.